CAPITAL GOODS IMPORTS, THE REAL EXCHANGE-RATE AND THE CURRENT ACCOUNT

Conventional open-economy aggregate models typically rule out capital goods imports - an assumption that is completely arbitrary. This paper shows that removing such an assumption in a standard intertemporal model with investment subject to adjustment costs has major consequences for the effects of macroeconomic policies and external shocks. Long-run output and the real exchange rate are inversely related. Fiscal policy disturbances and wealth transfers from abroad alter the long-run capital stock, and a fiscal expansion may have a crowding-in impact. The sign of the current account during the transition is ambiguous, and depends critically on intertemporal consumption substitutability and investment adjustment costs.